Unchained - Why the Crypto Industry Believes SEC Regulation by Enforcement Hurts US Consumers - Ep. 378

Starting point is 00:00:00 Just a quick note before we begin. On Thursday, SEC Chairman Gary Gensler released a video in which he said he's requested the agency staff, work with crypto exchanges so that they are, quote, regulated much like securities exchanges. This video came out after I recorded my conversation with Marissa Tashman, which is why we don't mention it. I'll link to the video, however, in the show notes. And now, on to the show. Hi everyone. Welcome to Unchained. You're no hype resource for all things crypto. I'm your host, Laura Shin, author of The Cryptopians. I started covering crypto seven years ago, and as a senior editor at Forbes was the first mainstream media reporter to cover cryptocurrency full-time. This is the July 29th, 2022 episode of Unchained. One Inch is a top Dex aggregator that finds the best rates across multiple networks. Why use a single decks when you can use them all?

Starting point is 00:00:58 Get one inch on your phone now or swap on one inch.io. With the crypto.com app, you can buy, earn, and spend crypto in one place. Download and get $25 with the code Laura, link in the description. Today's guest is Marissa Tashman, Policy Council at the Blockchain Association. Welcome, Marissa. Hi, Laura. Thanks so much for having me. I've been a fan of your podcast for a while. Well, thanks so much for listening.

Starting point is 00:01:29 Last week, the crypto world was rocked by charges by the Securities and Exchange Commission against a former Coinbase employee and two associates that they had engaged in insider trading to net over $1 million. However, many people in the crypto industry felt the real story had to do with the fact that, almost as an aside, the SEC also stated that at least nine of the crypto assets on Coinbase or securities. Tell us more about what the SEC did there and how they did it and why this was significant. Sure. So you're right that last week rocked the crypto world with this lawsuit that the SEC brought, which was brought in conjunction with the DOJ prosecution.

Starting point is 00:02:12 The DOJ prosecution, interestingly, was for wire fraud, whereas the SEC lawsuit was for insider trading, which necessarily requires insider trading of securities. So when the SEC brings a lawsuit for insider trading, they need to prove that whatever the asset that was being traded is a security. So like you mentioned, the SEC named nine different tokens in this lawsuit, and they alleged that these tokens were securities, but the tokens are not actually defendants in the lawsuit. So the tokens have no opportunity. So the tokens have no opportunity. to defend themselves, even though the SEC has the burden of proving that the tokens are actually securities. And so that's kind of maybe a roundabout way to do that. Why didn't the SEC just

Starting point is 00:03:03 directly charge either those coin issuers with offering unregistered securities or Coinbase for running an unregistered national securities exchange? I mean, it's hard to tell. I think one reason could be when the SEC goes after an individual defendant, they're more likely to, the individual defendant is more likely to settle. Likely, they'll have less resources than a coin base or these token projects. So like the SEC saw or is seeing in the Ripple case, for example, Ripple, you know, is fighting back really hard and putting all of their resources toward fighting the SEC, which the SEC, of course, is a government agency, and they do have a lot of resources. But I think the trend is that they like to avoid going to trial and they would prefer to settle. So that could be one reason.

Starting point is 00:03:54 I do see other people saying that this is kind of a way of sort of going after these small time players that don't have a way to defend themselves. But in this case, so if they win against these individuals, then does that mean effectively, those security, or sorry, those tokens will be deemed securities? Or is there any other way, you know, that this could play out? It's interesting because it could play out, well, I'm sure it could play out in many ways, but the two ways that come to mind, come to the front of my mind, one way is this gets taken, gets fully litigated. So either it goes through the summary judgment phase, which would mean that the court has to decide whether these tokens are

Starting point is 00:04:41 securities, or it goes through trial, which again, the court or the jury would decide, the jury decides the facts. So the jury would decide all the facts. And then the court would make the legal decision as to whether these tokens are securities. So in that, in those two instances, there would be some determination whether these tokens are securities. The other option is that the defendants settle with the SEC, which may be likely, especially given that there is a criminal prosecution going on. And normally when there's a criminal prosecution

Starting point is 00:05:18 that coincides with a civil litigation, the civil case gets stayed, which means that it basically gets paused. So the criminal case, once that finishes, then the defendants might be more likely to settle with the SEC. And in that case, nobody is deciding whether these nine tokens are securities, but the SEC effectively has labeled them as securities. I mean, labeled them in like a public court filing. So that has consequences for the tokens. They might get taken off certain exchanges. And we know now that the SEC has the opinion that these are securities. So effectively, you know, it's almost the same thing. And so then in that hypothetical scenario, then there would never be any official process by which these would be labeled as securities. And for that reason, then would we also

Starting point is 00:06:14 not get the reasoning behind why they were labeled as securities? Right. And that's the issue with what the SEC is doing. I mean, they're essentially regulating by these enforcement actions. And in this instance, they're enforcing against someone who isn't actually, you know, the entity that's creating or running these tokens. So the tokens themselves don't have an opportunity to defend themselves or argue that they're not securities, yet the SEC has the power to label them as such. And is there any process by which the token issuers or the exchanges could try to force the SEC to reveal their reasoning or go through some kind of process to officially label them as securities? It's possible that they could intervene, although I haven't done the full legal

Starting point is 00:07:05 analysis of what that requires and whether that actually is allowed. But sometimes in a civil lawsuit, another party who's interested in the case could intervene and basically state their interest and ask the court to decide, you know, how the case impacts them. But they shouldn't have to do that. That's like the main point, is that if the SEC wants to label these tokens as securities, they should have just named the tokens themselves, so then the tokens could, or the token projects could fully defend themselves. But otherwise, no. Oh, interesting. You know, not that I'm a legal person, but it does seem like this should be something that's hashed out in a kind of clearer manner. Yeah, I have noticed a bunch of crypto people in the industry and also SEC Commissioner

Starting point is 00:07:57 has a purse as well as CFTC Commissioner Caroline Pham. They've both been criticizing and like I said, other crypto people, they've all been criticizing the SEC for conducting what they call regulation by enforcement. What does that mean? And why do you think they seem to think this is a bad thing? Yeah, I mean, I definitely agree with what they're saying. And it's great that they've been speaking out against what the SEC is doing. And interesting, you know, that Hester Pierce within the SEC is also speaking out against it. and when another regulatory agency speaks out against the SEC, that there's some strength to that. So regulation. I should clarify that Hester Purriss remarks came before this happened, but she, you know, has criticized the SEC for this.

Starting point is 00:08:44 Yeah. But Caroline Fam, her remarks were in direct response to this enforcement action. I think that same day, maybe within a few hours of the lawsuit being filed, Regulation by enforcement is rather than the SEC going through normal rulemaking procedures where there's a notice and comment period, they have to conduct some economic and industry analysis of the impact of the rule. And it allows the industry to weigh in on whether a rule makes sense and is tailored toward whatever the SEC is targeting in that rule. The SEC instead is going around that and going after entities through enforcement actions and basically stating their opinions of how, in this case, like the Howie test, for instance, which is the test that we use to decide whether an asset is a security. And so they outline their opinions in either a court document, like a complaint, or sometimes like in the case. case of BlockFi, just in settlement papers. So there's no official rulemaking process, and yet the

Starting point is 00:09:58 industry has to look at these opinions that the SEC writes and glean their insights from it and somehow apply it to their own businesses without much guidance. So it's more like reading tea leaves than having some clarity. Right. That's a perfect analogy. And, And it's tough because the SEC is not, the individual entities are not in a position to make arguments and defend, you know, what they're doing and their business models. So it's not fair. They don't really have an opportunity to be heard. In a moment, we're going to talk about the consequences of this type of regulation.

Starting point is 00:10:40 But first, a quick word from the sponsors who make this show possible. Join over 10 million people using crypto.com. the easiest place to buy, earn, and spend over 150 cryptocurrencies. Spend your crypto anywhere using the crypto.com visa card. Get up to 8% cash back instantly, plus 100% rebates for your Netflix, Spotify, and Amazon Prime subscriptions. Download the crypto.com app now and get $25 with the code Laura. Link in the description. Back to my conversation with Marissa.

Starting point is 00:11:14 Lindsay Lynn, a partner at Dragonfly Capital, tweeted that the SEC's regulatory approach has created what she calls perverse incentives, such as high concentration of tokens being allocated to VCs and accredited investors pre-launch or projects being reluctant to be fully transparent for fear of being deemed decentralized and responsible founders choosing not to build in crypto, along with other things such as the U.S. consumers losing out on crypto innovation. What's your take on her perspective here? Do you agree that the SEC is doing things that actively harm crypto consumers in the U.S.? Definitely. I think that even though the SEC states that one of their goals is to promote innovation, it's really doing the opposite. And it's making entrepreneurs,

Starting point is 00:12:04 developers, entities really hesitant to do business in the U.S. because they're really there's no guidance whatsoever. So, I mean, the last guidance was in April of 2019, and since then, there hasn't been anything except for these enforcement actions. So they're in a tough spot and they're really guessing. And what makes it worse is that the SEC has said in public statements to the media that companies should come in and talk to them and seek guidance directly. And there have been instances of that. And then the SEC, you know, will send a subpoena or request depositions and then file an enforcement action against them rather than actually help guide the company to be compliant. The industry wants to comply. And like companies and

Starting point is 00:12:53 entrepreneurs want clarity. Wow. So it's almost like they're being punished if they try to be good actors? Right, right, which is so unfortunate because there's so much innovation that's happening in this space and it really just gets squashed when people who want to comply can't because it's so unclear. So the same day that the insider trading charges came out, Coinbase announced that it had filed a petition asking the SEC to create rulemaking on digital asset securities. What did the petition say and what do you think of it? Do you think this was the right move? Yeah, it sort of outlines what we've been talking about, where they want clarity and they want to comply. And I think that it's a timely move.

Starting point is 00:13:38 I'm not sure if the two were connected. I believe that they were not, at least according to the public statements that have been made. But we'll see how the SEC responds to that. I think the SEC has its own agenda. And, you know, they're not mandated when it's. Coinbase sends a request like this. I don't believe that there's any sort of, it's not like Congress mandating that they do something. So we'll see how they respond, but it would be great that if there was some clarity in the guidance. Oh, so there's no requirement that they even

Starting point is 00:14:13 respond to this? I don't believe so. I haven't looked into the question directly, but I don't, unless they sued the SEC, which I know that they didn't, but I don't believe that they have to comply with a private parties request. So on the flip side, there are people who kind of criticize Coinbase as well. Like for instance, they wrote a blog post titled, Coinbase does not list securities, end of story. And some people felt this was sort of circular or self-referential logic. Like, we don't think it's a security, therefore it's not. So what do you think of Coinbase's process for listing tokens? I know that they have a rigorous process that they go through to do this analysis under the Howie test.

Starting point is 00:15:02 I don't know, you know, exactly what their internal processes are, but I do trust that they go through a rigorous process and they analyze each token individually and they have lawyers on their team who are all very smart and they know securities law. So, but do you, you know, like in, I guess in this. sort of instance where they're declaring that they don't list any securities. Would you say that that's like a factual statement? Well, it's hard to say whether it's a factual statement because I haven't looked at every single asset, you know, that Coinbase lists and done that Howie analysis. But I do trust that they're doing that internally and that they have a rigorous process. I mean, there are severe consequences for being an unregistered exchange. So I would think that they want to avoid, you know, being prosecuted by or being found liable for operating as an unregistered

Starting point is 00:16:03 exchange. And they have these rigorous compliance processes, you know, in place to avoid that. Bloomberg then reported that the SEC is investigating Coinbase for whether or not an improperly listed securities on its platform. Some people criticize the SEC for having let Coinbase go public and having apparently been fine with its listing process at that time, how do you see these seemingly contradictory actions? Yeah, it's interesting. And they seem to contradict on the outside. I think that, of course, you know, there's changes that can happen within a company to,

Starting point is 00:16:41 at one point, you know, they might not have had unregistered securities on there. And then now the SEC thinks differently. So we'll see what happens with this investigation, but it also highlights the fact that that Coinbase was not brought into the lawsuit, to the Wahee lawsuit. So they could have brought Coinbase in there and made Coinbase defend themselves in court. And Coinbase would have had an opportunity to be heard. But instead of doing that, they're going through this investigatory process where there is no judge mediating between the two of them. And Coinbase is now in a position. where they have to comply with the SEC's document requests and, you know, subpoenas, depositions, and then the SEC ultimately will decide whether or not they want to bring a lawsuit against Coinbase. But I expect that Coinbase will fully defend their position based on their rigorous analysis that they've done on these tokens and all the tokens on their platform. So obviously there is so much going on in this realm of whether or not.

Starting point is 00:17:49 are not, you know, certain tokens are securities. What is the process by which companies should, you know, choose to engage with them? Or even, you know, if there are certain projects that want to launch tokens, you know, what is the way to do that in a compliant way in the U.S.? So what are you looking at next? Like, what do you think happens next and sort of what's on the horizon that you're watching out for? At the blockchain association, we've been trying to think about various legislations and bills that can help clarify this issue. So whether something is a security or a commodity, and if it's a commodity, it would fall under the CFTC's jurisdiction. Essentially, we're trying to find ways that can bring clarity to the industry and then also, you know,

Starting point is 00:18:33 are likely to get passed into actual legislation rather than just remain a bill. And then another piece of that is helping educate not only the industry, but helping educate lawmakers and regulators about crypto more generally and the technology. So regulators can then develop narrowly tailored regulations that actually, you know, make sense and aren't impossible to apply to crypto. Obviously, you senators Cynthia Lemis and Kristen Gillibrand, did propose, you know, such a regulatory framework. What do you think of that and what do you think the chances are that we might see some action on that soon? I mean, it's a great start for sure.

Starting point is 00:19:19 And it definitely helps clarify the securities slash commodities issue. And it gives jurisdiction to the CFTC, which we really like. In terms of the chances of it getting through, I think we might see something next year, Congress is out of session starting next week in August. And then there's the election in November. So likely nothing will get past this year. But we've had some great conversations. And it's really, I mean, it's a comprehensive bill. And of course, there's room for improvement, but it's a really great start. All right. Well, it has been such a pleasure having you on Unchained. Thank you so much, Laura. Don't forget, next up is the weekly news recap. Stick around for this week in crypto after this short break. To swap crypto,

Starting point is 00:20:11 a user has to choose among hundreds of dexes on multiple networks, all offering different rates and fees. Do you want to avoid that hassle? Swap on one inch, a top dex aggregator built to get you better rates than any single decks. Enjoy unlimited liquidity across multiple networks and top-level security. Get one-inch on your phone now or swap on one-inch.io. Thanks for tuning in to this week's news recap. Voyager rejects FTX and Alameda proposal. Last Friday, FTX and Alameda research offered a proposal to grant quick liquidity to customers of Voyager, the recently declared bankrupt crypto lender. In summary, Alameda would purchase customer assets from

Starting point is 00:21:00 Voyager with cash and put them in escrow. At the same time, FTX would authorize Voyager customers to create an account and quickly cash out or hold their distressed remaining assets on the FtX exchange, as Sam Bankman-Fried described in a tweet threat on the topic. Voyager quickly shot the proposal down, filing its declination on Sunday and describing the proposal as a low-ball bid dressed up as a white knight rescue, reports the block. In the filing, Voyager claimed that FTX and Alameda made misleading or outright false claims and ignored the tax implications of converting crypto claims to U.S. dollars. According to the block, Voyager would be willing to listen to a serious proposal that could potentially better its customers over the

Starting point is 00:21:48 crypto lender's current plans. Bitcoin and digital assets rally on 75-point rate increase, following the Federal Reserve's decision to increase interest rates by some of the basis points, the crypto market experienced a substantial surge, as Bitcoin swelled 9.6% on Wednesday, and Ether jumped 15.5%. After the increase, rates are between 2.25% and 2.5%, the highest levels since before March 2020. As for why the rate increase is good for Bitcoin, Alfonso Pekatello, author of the MacroCumbus newsletter, explained on Twitter, If the Fed isn't going to force tighter financial conditions on autopilot anymore, real yields will actually start declining again. With that in mind, he added, when real yields decline,

Starting point is 00:22:38 valuation intensive and risk sentiment-driven asset classes outperform. That's because the marginal return for owning cash US dollars becomes less attractive and the incentive to chase risk assets is larger, such as QQQQ, which tracks the NASDAQ 100, and Bitcoin. In related news, gross domestic product declined at an annual pace of 0.9% in Q2. Celsius customer emails leaked. On Thursday afternoon, bankrupt crypto lender Celsius emailed its customers stating that their email addresses had been leaked to a third party. The breach occurred through its vendor, customer.io, and was the same vendor that had leaked open-sea customer email addresses a month ago. Zero Hedge tweeted, just when you thought the Celsius circus

Starting point is 00:23:26 couldn't turn any more ridiculous. Cracken to be fined for serving Iranians. Crackin, a crypto exchange valued at $11 billion, is reportedly under investigation by the U.S. Treasury Department. The New York Times broke the news on Tuesday, revealing that the Office of Foreign Assets Control has been investigating the exchange since 2019 for allegedly violating U.S. sanctions by allowing users in Iran to trade in cryptocurrencies. As for what the investigation is likely to find, the report confirmed the existence of a spreadsheet sent in Cracken's company Slack channel, showing that the exchange had 1,522 people with residences in Iran, along with 149 in Syria and 83 in Cuba, which are also sanctioned countries.

Starting point is 00:24:14 The Times expects there to be a fine. Speaking of regulation, the much-anticipated bipartisan staple coin bill is being shelved over the August congressional recess without draft text, seeing the light of day. Representative Maxine Waters explained in a statement, although the ranking member, Patrick McHenry, Secretary Janet Yellen and I have made considerable progress towards an agreement on the legislation, we are unfortunately not there yet and will therefore continue our negotiations over the August recess. She added, according to the block, we want to make sure that this bill, this law, is technically proficient and a workable law. We don't want a dead letter as soon as we pass this thing. The U.S. Commodities and Futures Trading Commission is transforming its FinTech Group,

Starting point is 00:25:01 lab CFTC, into a new unit called the Office of Technology Innovation, which will help the regulator handle the crypto space. Senators Pat Toomey and Kirsten Cinema introduced a bill exempting small crypto transactions from capital gains. The bill would make any transaction under $50 free of capital gains taxes and includes an increase to adjust for inflation. Harmony's $100 million, solution, inflation. After losing $99 million in the Horizon Bridge Hack, the Harmony team published its reimbursement plan this week with the hopes to make wallets either 50% or 100% whole. The proposal establishes a three-year program structured around a hard fork that will inflate the supply of one, Harmony's native token, through two different options, a 50% reimbursement with a minting of

Starting point is 00:25:53 2.48 billion tokens, or a 100% reimbursement with a minting of 4.98 billion tokens. With a total supply of 13.1 billion one, the proposal plans to print an additional 19% or 38% won tokens to pay back the users affected by the attack via inflation. The team explained the decision as forward-looking. We decided against using the foundation treasury in the interest of the longevity and well-being of the project, as reimbursing from the Treasury would greatly hinder the foundation's ability to support the growth of Harmony and its ecosystem. Harmony Foundation is committed to continuing supporting Harmony for years to come, and plans to reserve the foundation tokens to facilitate this. Comments on the governance forum post took umbrage with this approach. For example,

Starting point is 00:26:45 foreign participant, diluted to zero, was especially frank with his or her disdain regarding Harmony's proposal. Two weeks for this shitty proposal and no repug? Payment in one, aka inflation, and coins becoming worthless, a hard fork to kill the small chance this chain had. WTF, it boggles my mind that not only do we lose money, we also pay for the reimbursement ourselves via inflation. You guys have no shame to call this a reimbursement proposal. He or she wrote. The community will begin voting on the proposal on August 1st. The hacks never stop. This week, we saw two multi-million dollars hags. Audius, a Web3 music platform, lost $6 million in governance tokens after a hacker was able to manipulate an old security bug in the open Zeppelin contract forming the basis for Audius's

Starting point is 00:27:39 governance system. Overall, the attacker was able to get away with roughly $1 million. On Thursday, Nirvana, a Solanibased DeFi protocol, lost $3.5 million to a flash loan attack that drained its liquidity poles. As of press time, its governance token ANA is down 80%. Keeping up with the governance posts. Lido Finance, the leading decentralized staking service known for its Steeth product, has been locked into a community battle over the seal of 2% of Lido-Dal governance tokens, which Lido is attempting to swap for stable coins to secure runaway. for a potentially years-long bear market. Earlier this week, the Lido Dow voted against a proposal calling for Dragonfly capital

Starting point is 00:28:24 to purchase 10 million LDO tokens, or 1% of the LDO supply, over concerns stemming from a lack of vesting. By Tuesday, the community returned with a new proposal that called for a vesting arrangement of one year and also increased the purchase price from $1.45 to a seven-day average of the LDO price at the time, plus a 5% premium. By the time this podcast airs, the new vote should be underway. Sushi Swabs team put forward Jonathan Howard, a software engineer with NFT experience for head chef this week. The proposal, if passed, would call for an ambitious salary plan. The doubt would be on the hook to pay Howard $800,000 in staple coins on a yearly basis, plus roughly $750,000 worth

Starting point is 00:29:11 of sushi tokens over a four-year vesting period. On top of that, there is a 350,000 sushi bonus for hitting certain metrics and a price-rise payout that could net Howard $8.35 million if sushi rose above $11 again. While many of the comments were positive, it was noted by community member DR Anon 9-11 that such an aggressive offer could leave sushi swap without much of a budget. Assuming the funds for this proposal come out of the operational multi-sig, which has 2.67 million USDC and 250,000 sushi, if this guy leaves day one, he will take with him 60% of the USDC and all of the sushi, with still 50k yet to be paid. The treasury only has 90k USDC, with a rest being almost entirely the $15 million worth of sushi, wrote DR. Annan 9-9-11.

Starting point is 00:30:10 As at press time, 57% of 102 voters had voted for Jonathan to take over. Time for fun bits. Coinbase's D-Gen trilogy. Well-made, but Crypto-Natives gave it a thumbs down. Coinbase has had a tough few weeks. It had to stall hiring of former employees being charged with insider trading. And now, as covered in this week's episode, the SEC is investigating the exchange for supporting the trading of securities. Even with all that, Coinbase is still shipping, as evidenced by the unveiling of a trailer for part one of the D-Gen trilogy,

Starting point is 00:30:47 a Bored Ape Yacht Club-themed movie series. While I thought it was well done, the male voiceover actor is awesome. Many crypto-natives didn't seem to have the same opinion. Greg, unfortunately, I'll never be able to get those five minutes of life back. Aubrey Strobel. Did you lay off employees to fund the production of this? Coin Bureau. The SEC should rather be investigating this for illegally inducing cringe.

Starting point is 00:31:12 Thanks so much for joining us today. To learn more about Marissa and the SEC's regulation of crypto, check out the show notes for this episode. Unchained is produced by me, Laura Shin, with help from Anthony Yun, Matt Pilchard, Bonnar Manovich, Pamajimdar, Shashon, and CLK transcription. Thanks for listening.

Unchained - Why the Crypto Industry Believes SEC Regulation by Enforcement Hurts US Consumers - Ep. 378

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